Will Weakness in IOL Chemicals and Pharmaceuticals Limited's (NSE:IOLCP) Stock Prove Temporary Given Strong Fundamentals?

IOL Chemicals and Pharmaceuticals (NSE:IOLCP) has had a rough three months with its share price down 15%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study IOL Chemicals and Pharmaceuticals' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for IOL Chemicals and Pharmaceuticals

How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for IOL Chemicals and Pharmaceuticals is:

50% = ₹4.0b ÷ ₹8.1b (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.50.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of IOL Chemicals and Pharmaceuticals' Earnings Growth And 50% ROE

To begin with, IOL Chemicals and Pharmaceuticals has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 13% the company's ROE is quite impressive. Under the circumstances, IOL Chemicals and Pharmaceuticals' considerable five year net income growth of 79% was to be expected.

Next, on comparing with the industry net income growth, we found that IOL Chemicals and Pharmaceuticals' growth is quite high when compared to the industry average growth of 14% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if IOL Chemicals and Pharmaceuticals is trading on a high P/E or a low P/E, relative to its industry.

Is IOL Chemicals and Pharmaceuticals Making Efficient Use Of Its Profits?

IOL Chemicals and Pharmaceuticals has a really low three-year median payout ratio of 4.7%, meaning that it has the remaining 95% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

While IOL Chemicals and Pharmaceuticals has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend.

Conclusion

Overall, we are quite pleased with IOL Chemicals and Pharmaceuticals' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. You can see the 2 risks we have identified for IOL Chemicals and Pharmaceuticals by visiting our risks dashboard for free on our platform here.

If you decide to trade IOL Chemicals and Pharmaceuticals, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.